The Biggest Myth About Taxes and the Fiscal Cliff
Another week’s gone by and there’s still no resolution on the Fiscal Cliff. The only thing that’s changed, really, is investors’ fear.
As BMO Capital Markets’ Brian Belski, says, “A resolution to the so-called ‘Fiscal Cliff’ is anyone’s guess at the moment, but what is clear based on our client conversations is that the prospect of higher taxes has clearly spooked investors.”
If we want hard, non-anecdotal evidence, look no further than the recent performance of dividend stocks. Instead of flocking to the safety of this corner of the market, investors are fleeing from it.
As Bespoke Investment Group notes, “Instead of outperforming as the market has declined [since Election Day]… dividend payers in the S&P 500 have underperformed.”
The conclusion?
“This clearly shows that investors are making a strategic shift out of dividend payers due to the looming tax increase on dividend income,” said Bespoke.
That’s a huge mistake. Again, bailing on dividend stocks – or all stocks, for that matter – simply because of the threat of higher taxes makes no sense. Even if most pundits might be telling you otherwise.
And today, in honor of Myth-Busting Monday, I’m going to prove it.
Higher Taxes, Higher Stock Prices
Longtime readers know I’ve already dedicated considerable ink to debunking the myth that a dividend tax rate increase would be disastrous.
You can re-read my work here, here and here. Or, if you prefer, I can sum it up for you with a single line from my previous commentary: “Fears over a dividend tax rate hike are completely overblown.”
I’m going to go one step further today and say that fears over any tax hike are completely overblown, especially concerning the impact on the stock market.
And here’s the evidence to back me up, courtesy of Minyanville’s James Debevec.
As you can see, stocks actually perform best when dividend tax rates are the highest. I know. It’s totally counterintuitive. But the facts don’t lie.
If you’re stubborn and just aren’t ready to relinquish your fears over a tax hike leading to a bear market, here’s another dose of truth serum, this time courtesy of BMO…
“According to our work, average market returns are quite strong in years immediately following tax hikes,” says Belski.
Given the average rise of 17.8% over the first year, I’d say the returns are “quite strong,” indeed.
Note that the returns following tax cuts are “well below historical norms,” as Belski says. So does that mean we should favor higher and higher taxes?
Not just “no.” But “hell no!”
As Belski explains, “This [underperformance] is because the economy happened to be weaker in those years, not because of tax policy.”
Bottom line: I’m the last person to advocate higher taxes. I subscribe to John Maynard Keynes’ school of thought that “the avoidance of taxes is the only intellectual pursuit that still carries any reward.”
When it comes to higher taxes as a result of the Fiscal Cliff, though, they appear unavoidable. But in this situation, in the famous words of FDR, “The only thing we have to fear is fear itself.” Because contrary to conventional wisdom, tax hikes will not derail the stock market.
And once again, we’ve busted another Wall Street myth. All in a day’s work!
If you have any Wall Street wisdom you’d like us to put to the test, let us know at feedback@wallstreetdaily.com. While you’re at it, feel free to let us know what you think about today’s column – or any of our recent work at Wall Street Daily.
Ahead of the tape,
Louis Basenese
Related Topics: Economy and Politics, Myth Busting, Think Contrarian, U.S.
Louis,
Your article “The Biggest Myth About Taxes and the Fiscal Cliff” falsely accounting for the increased historical stock market returns from the higher tax rates. Though you can’t explain the rationale, you are mistakenly attributing causality of the stock returns to tax rates.
The level of – and change in – tax rates tells us more about the general economic conditions and the public and political environment. Both the tax rates and the stock market returns are themselves dependent on the general economic, social and political setting. Just look at the time blocks in the table and you see how tax policy and stock performance reflect the environment.
Not much of a myth there for you to bust, just plain logic.
Tom
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Louis Basenese Reply:
December 3rd, 2012 at 10:05 am
Tom – I appreciate the feedback. Check out my latest column for some clarification on the points you raise.
http://www.wallstreetdaily.com/2012/12/03/another-tax-myth-bites-the-dust/
Best,
Lou
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Reading the print and making a reasonable evaluation. I can’t wrap my head around the nerve of them mentioning we won’t survive the fiscal cliff. Tell them to wake up and face reality.
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Folks need dividends regardless of tax rates. The “cliff is bull, created by this joke administration. The real issue is job creation that the jokers refuse to effectively address. Simple and historically proven. And Obama and his joker staff know this but they are deathly afraid to be truthful, just listen to the trash from the mouth of jay carney . How can anyone believe his transparent lies (the only transparency in this regime).
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I would like to know why this country has no back bone any more . Obama should have been Impeached already right along with his joker staff. the President should not lie to his country.
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David Cole Reply:
December 31st, 2012 at 12:22 pm
Amen to that Thomas. Lets go over the so called cliff (that really doesn’t exists). What a lie. The economy will be OK. It may stagger a bit but nothing more.
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I think this is too simplistic. There are likely a lot of other factors involved. I think a lot of the big returns are due to the Reagan tax cuts, which resulted in a big economic boom through Feb, 2000. The market started dropping March 2000. NASDAQ dropped 55% from March, 2000 to the inauguration of Bush.
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Let’s make this simple about taxes since there’s a tough a war about it. When you raise taxes people have less to spend on gas and food, etc. Major companies jump ship to a tax friendly state or country so they can optimize there profit.
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